From April 6, 2011, the Government reduced the annual pension allowance from £255,000 to £50,000. Despite such a big cut, opportunities exist to pay contributions of more than £50,000 without incurring tax charges and, in addition, tax relief is available at marginal rates.
Rules now allow those who have maximised their annual allowance of £50,000 in 2011/12 to carry forward unused annual allowance from pension input periods ending in the three previous tax years, providing they were a member of a registered scheme in those years.
Furthermore, there has been a recent relaxation of the carry-forward rules and this rollover of unused allowances could allow large single contributions.
The lower annual allowance of £50,000 will mean attention needs to be given to Pips. To plan effectively you will need to know when your clients’ Pips start and end, together with the pension input amount in the last three tax years. These Pip dates will not necessarily align with the tax year and the scheme administrator will be able to confirm this.
A £50,000 annual allowance will apply to 2008/09, 2009/10 and 2010/11 to determine any unused carry- forward allowance. Before being able to carry forward any unused allowance, the annual allowance in the tax year in which the pension input amount is being made must first be used up.
As a result, using carry forward creates the opportunity of paying a tax-relievable pension contribution of up to £200,000 and, furthermore, why not consider changing the Pip and then contributing a further £50,000 this tax year. However, you must bear in mind the following:
- Pips can no longer be changed retrospectively.
- Arrangements must only have only one single Pip ending in one tax year.
- When planning to pay large personal contributions, clients still remain capped at 100 per cent of net relevant earnings for receiving the tax relief on their own contributions made during the current tax year. What they have earned in previous tax years is inconsequential.
Employers can pay any carry forward contributions on behalf of the employee. These are deductible against corporation tax provided they are wholly and exclusively for the purposes of the employer’s trade.
If a client is or has been a member of a defined benefit occupational scheme, the calculations for testing against the annual allowance are more complex. DB accrual for 2008/09, 2009/10 and 2010/11 is calculated using a factor of 16, with the opening value increased by the consumer price index for the September ending immediately before the tax year in question.
We must not forget there are some transitional rules for contributions where the Pip ends in the 2011/12 tax year and straddles October 14, 2010 – the date the annual allowance reduction was announced – which can complicate matters further.
For such cases, the Pip is divided into two parts – pre- October 14 and post-October 13. Provided the total pension input amount for the period after October 13 was less than £50,000 and the total for the combined periods was less than £255,000, the member will not suffer a tax charge for the Pip ending in 2011/12.
For rights accruing in DB schemes, a factor of 10:1 applies to accruals up to October 13, 2010 and 16:1 on or after October 14.
Those individuals who may be in a position to benefit from using carry forward are:
- those on high incomes whose contributions have been limited previously under anti-forestalling rules;
- those nearing retirement aiming to boost their fund;
- those opting for fixed pro-tection before the lifetime allowance reduces to £1.5m from April 6, 2012 with a final chance to make contributions prior to that date;
- employees receiving large bonuses/redundancy payments or self-employed people enjoying an increase in profits from a good year;
- company directors seeking to reduce the corporation tax bill; and
- DB scheme members receiving big salary rises resulting in a significant increase in accrued pension benefits.
Guidance issued by HM Revenue & Customs on November 25, 2011 has opened up even more opportunities to make bigger contributions using carry forward.
Previous to this date, individuals who have contributed more than £50,000 in the Pips ending in 2009/10 and 2010/11, known as the transitional years, were deemed by HMRC to have mopped up some or all of the carry forward allowance from the earlier years.
These old rules had penalised those who made sizeable contributions in the past couple of tax years. For example, if an individual had made no contributions in both the 2008/09 and 2009/10 tax years and subsequently contributed £150,000 in 2010/11, this contribution would have wiped out any carry forward allowance from the two previous years.
This restriction has now been removed for these transitional years and in the example (see case study) a total of £100,000 – 2 x unused allowance of £50,000 – can be carried forward from 2008/09 and 2009/10.
This easement is in place only for these transitional years and if clients use carry forward in later years and exceed the £50,000 limit, the excess will use up the amounts available from previous years.
For clients earning more than £100,000 who are in no hurry to make large contributions this tax year, an alternative option would be to spread any unused annual allowances over the next couple of tax years to regain their personal allowance more than once. This may turn out to be more tax-efficient because the personal allowance is set to increase again next year.
The lifetime allowance soon reduces to £1.5m, meaning it is essential that affected clients make the most of this opportunity to top up their pension benefits to make maximum use of the protected lifetime allowance of £1.8m. If your clients are considering opting for fixed protection to protect their benefits from this reduction, they will not be permitted to make any further contributions after April 5, 2012.
As we move further into the tax year, clients may be better placed to know what their total taxable earnings will be this tax year, giving an indication of the potential size of any tax-relievable personal contribution that could be made.
Furthermore, HMRC’s recent relaxation of the rules has potentially opened up scope to make even bigger contributions through the use of carry forward and will mean that some clients will want to revisit their position.
Janet earns £190,000 and her contributions have been restricted since April 2009 because she was caught by the anti-forestalling rules. As she is subject to 50 per cent tax, she wishes to pay a large contribution into her Sipp to offset her tax liability and boost her pension in advance of her retiring in May 2012. Here is an example of how much she can carry forward (for simplicity her Pip corresponds with the tax year):
A contribution of £130,000 gross can be made – £80,000 carry forward allowance plus the £50,000 allowance for 2011/12. As the carry forward facility works on a three-year rolling basis and the oldest year must always be used first, the £20,000 carry forward amount from 2008/09 would not be available after the 2011/12 tax year.
Janet makes this payment in February 2012 and then makes a nomination to shorten the end date of her PIP from April 5, 2012 to March 12, 2012. On March 13 she sends in another cheque, this time for £50,000. This falls into the PIP running March 13, 2012 to March 12, 2013, which is measured against the annual allowance for 2012/13.
In total, Janet has paid £180,000 in quick succession during the tax year 2011/12 and by manipulating the end date of the PIP, the contributions are spread, for testing purposes, across two annual allowances.
Tax relief will be granted at Janet’s marginal rate and as a higher/additional-rate taxpayer she will be able to claim back her higher -ate tax through her self-assessment. As she has earned income of £190,000, she will be paying 50 per cent tax on income exceeding £150,000. On income exceeding £35,000 she will be subject to 40 per cent tax.
This contribution will reduce her taxable income below the £100,000 threshold, which means her personal tax allowance of £7,475 will be restored. This means an effective rate of tax relief of 60 per cent on part of the contribution.
In addition to Janet’s big tax saving, she will also receive a 25 per cent tax-free lump sum when she comes to take her benefits next year.